the "volcker shock"

In 1979 President Carter appointed To the federal reserve Paul Volcker. At the time his appointment was seen as part and parcel with Carter's "austerity" program (austerity is generally seen as reducing spending, increasing taxes and being "less accommodating" to private enterprise. Increasing interest rates is what the third point generally means. I will return to this later). In the mainstream economics before the 1970's, a curve called the "Phillips curve" purported to explain that their was a determinate relationship between inflation and unemployment. That is, when the rate of inflation goes up, the rate of unemployment was supposed to go down a certain amount and vice versa. The "stagflation" (ie high levels of unemployment and inflation) of the 1970's completely exploded this view.

In it's place (whether merited or not) Milton Friedman came to prominence with "monetarism". His basic idea was that money is "neutral" in the long run ie it doesn't effect any real variables (like employment, distribution of output etc. see earlier post for a differing view). the basic equation monetarists use to explain this idea is MV=PQ. In this equation M is money (as in cash and bank deposits), V is velocity or how much money circulates in a given period of time, P is the level of prices and Q is the amount of output produced. Milton Friedman argued that velocity was basically constant and in the long run the economy tended towards full employment (the unemployment that did happen was caused by inefficient labor markets ie unemployment insurance and unions). Because of this, it was easy for him to draw the line of causation from money to prices. In other words growth in the "money supply" caused growth in the rate of price increases (look at this earlier post for a more detailed explanation and a reverse the causation argument).

Back to Volcker. He was largely seen as implementing Friedman's agenda. he was to lower, the rate of growth of prices by lowering the rate of growth of money. In practice, this meant a lot of volatility in interest rates (if you target interest rates, you have to accept the level of bank reserves and vice versa).Note also that Friedman declared that labor unions were making labor markets more inefficient and thus restricting output (and creating unemployment). Marxists (and other analysts) such as Doug Henwood argue that the “Volcker shock” was primarily aimed at breaking the power of labor. It's also notable that average people were not involved in this battle ideas. Workers were only a “problem” that needed to be solved.